19 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from_________to_________ Commission file number 0-11129 COMMUNITY TRUST BANCORP, INC. (Exact name of registrant as specified in its charter) Kentucky 61-0979818 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 208 North Mayo Trail Pikeville, Kentucky 41501 (address of principal executive offices) (Zip Code) Registrant's telephone number (606) 432-1414 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common stock - 11,070,704 shares outstanding at July 31, 1999
PART I - FINANCIAL INFORMATION Item 1. Financial Statements The accompanying information has not been audited by independent public accountants; however, in the opinion of management such information reflects all adjustments necessary for a fair presentation of the results for the interim period. All such adjustments are of a normal and recurring nature. The accompanying financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by generally accepted accounting principles or those normally made in the registrant's annual report on Form 10-K. Accordingly, the reader of the Form 10-Q should refer to the registrant's Form 10-K for the year ended December 31, 1998 for further information in this regard. Index to consolidated financial statements: Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Cash Flows 5 Notes to Consolidated Financial Statements 6 2
Consolidated Balance Sheets June 30 December 31 (In thousands except share data) 1999 1998 Assets: Cash and due from banks $ 79,261 $ 97,487 Interest bearing deposits in other financial institutions 436 646 Federal funds sold 42,867 135,000 Securities available-for-sale 299,065 301,052 Securities held-to-maturity (fair value of $71,236 and $83,097, respectively) 71,988 83,359 Loans 1,558,454 1,502,386 Allowance for loan losses (25,487) (26,089) Net loans 1,532,967 1,476,297 Premises and equipment, net 53,351 54,796 Excess of cost over net assets acquired (net of accumulated amortization of $10,995 and $9,559, respectively) 60,990 62,497 Other assets 34,181 36,905 Total Assets $2,175,106 $2,248,039 Liabilities and Shareholders' Equity: Deposits: Noninterest bearing $ 257,073 $ 281,302 Interest bearing 1,621,711 1,639,839 Total deposits 1,878,784 1,921,141 Federal funds purchased and other short-term borrowings 40,424 43,405 Other liabilities 15,519 13,491 Advances from Federal Home Loan Bank 18,656 51,384 Long-term debt 53,724 53,823 Total Liabilities 2,007,107 2,083,244 Shareholders' Equity: Preferred stock, 300,000 shares authorized and unissued Common stock, $5 par value, shares authorized 25,000,000; shares issued 1999-11,070,825; 1998-10,064,969 55,354 50,325 Capital surplus 45,910 28,057 Treasury Stock, 7,760 shares of common stock at cost (175) 0 Retained earnings 68,067 84,827 Accumulated other comprehensive income (1,157) 1,586 Total Shareholders' Equity 167,999 164,795 Total Liabilities and Shareholders' Equity $2,175,106 $2,248,039 The accompanying notes are an integral part of these statements. 3
Consolidated Statements of Income Three months ended Six months ended June 30 June 30 (In thousands except per share data) 1999 1998 1999 1998 Interest Income: Interest and fees on loans $34,419 $34,442 $68,068 $68,145 Interest and dividends on securities Taxable 4,536 3,088 9,222 6,460 Tax exempt 757 512 1,490 1,150 Interest on federal funds sold 985 603 2,328 798 Interest on deposits in other financial institutions 2 0 4 5 Total Interest Income 40,699 38,645 81,112 76,558 Interest Expense: Interest on deposits 17,850 16,433 35,879 32,278 Interest on federal funds purchased and other short-term borrowings 473 402 957 925 Interest on advances from Federal Home Loan Bank 274 1,841 671 3,603 Interest on long-term debt 1,128 1,192 2,352 2,384 Total Interest Expense 19,725 19,868 39,859 39,190 Net interest income 20,974 18,777 41,253 37,368 Provision for loan losses 2,671 4,053 4,705 6,558 Net interest income after provision for loan losses 18,303 14,724 36,548 30,810 Noninterest Income: Service charges on deposit accounts 2,431 1,836 4,586 3,474 Gains on sale of loans, net 384 666 1,088 1,104 Trust income 648 479 1,163 911 Securities gains, net 0 12 0 12 Other 1,707 2,824 3,328 4,352 Total Noninterest Income 5,170 5,817 10,165 9,853 Noninterest Expense: Salaries and employee benefits 7,193 6,834 14,712 13,912 Occupancy, net 1,250 1,149 2,426 2,162 Equipment 1,176 939 2,439 1,895 Data processing 811 839 1,665 1,678 Stationery, printing and office supplies 407 458 772 839 Taxes other than payroll, property and income 356 544 797 1,065 FDIC insurance 25 71 147 133 Other 4,432 3,468 8,519 6,676 Total Noninterest Expense 15,650 14,302 31,477 28,360 Income before income taxes 7,823 6,239 15,236 12,303 Income tax expense 2,391 1,999 4,704 3,899 Net Income 5,432 4,240 10,532 8,404 Other comprehensive income, net of tax: Unrealized holding gains/(losses) arising during period (470) 30 (1,157) 130 Comprehensive income $ 4,962 $ 4,274 $ 9,375 $ 8,534 Basic earnings per share 0.49(1) 0.38(1) 0.95(1) 0.76(1) Diluted earnings per share 0.49(1) 0.38(1) 0.95(1) 0.75(1) Average shares outstanding 11,067(1) 11,069(1) 11,067(1) 11,069(1) (1) Per share data and average shares outstanding have been restated to reflect the 10% stock dividend issued on April 15, 1999. The accompanying notes are an integral part of these statements. 4
Consolidated Statements of Cash Flows Six months ended June 30 (In thousands) 1999 1998 Cash flows from operating activities: Net income $ 10,532 $ 8,404 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,862 2,420 Provision for loan and other real estate losses 4,733 6,574 Securities gains, net 0 0 Gain on sale of loans, net (1,088) (1,104) (Gain)/loss on sale of assets 1 (3) Net amortization of securities premiums 246 171 Net change in loans held for sale 1,465 1,220 Changes in: Other assets 5,000 1,492 Other liabilities 3,884 2,178 Net cash provided by operating activities 28,635 21,352 Cash flows from investing activities: Proceeds from: Sale/call of securities available-for-sale 1,278 2,189 Maturity of securities available-for-sale 47,242 29,131 Maturity of securities held-to-maturity 3,982 5,582 Principal payments on mortgage-backed securities 7,366 13,198 Purchase of: Securities available-for-sale (50,866) (12,613) Securities held-to-maturity 0 0 Mortgage-backed securities (10) 0 Net change in loans (62,735) (32,759) Net change in premises and equipment (855) (3,276) Other 0 1 Net cash used in investing activities (54,598) 1,453 Cash flows from financing activities: Net change in deposits (42,357) 24,804 Net change in federal funds purchased and other short-term borrowings (2,981) (20,751) Advances from Federal Home Loan Bank 0 31,000 Repayments of advances from Federal Home Loan Bank(32,728) (6,762) Proceeds from long-term debt 0 0 Payments on long-term debt (99) (96) Payments for redemption of common stock (535) (96) Issuance of treasury stock 291 67 Dividends paid (6,197) (4,026) Net cash provided by financing activities (84,606) 24,140 Net increase (decrease) in cash and cash equivalents (110,569) 46,945 Cash and cash equivalents at beginning of year 233,133 61,404 Cash and cash equivalents of acquired banks 0 176,358 Cash and cash equivalents at end of period $ 122,564 $ 284,707 The accompanying notes are an integral part of these statements. 5
Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies The accounting and reporting policies of Community Trust Bancorp, Inc. (the "Company"), and its subsidiaries on a consolidated basis conform to generally accepted accounting principles and general practices within the banking industry. Principles of Consolidation - The unaudited consolidated financial statements include the accounts of the Company and its separate and distinct, wholly owned subsidiaries Community Trust Bank, NA, Community Trust Bank, FSB, Trust Company of Kentucky, National Association, CTBI Preferred Capital Trust, and Community Trust Funding Corporation. All significant intercompany transactions have been eliminated in consolidation. 6
Note 2 - Securities Securities are classified into held-to-maturity, available-for- sale, and trading categories. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Available-for-sale securities are those which the Company may decide to sell if needed for liquidity, asset-liability management or other reasons. Available- for- sale securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax. The amortized cost and fair value of securities available-for- sale as of June 30, 1999 are summarized as follows: Amortized Fair (in thousands) Cost Value U.S. Treasury and government agencies $ 62,581 $ 62,654 Mortgage-backed pass through certificates 144,997 143,784 Collateralized mortgage obligations 40,909 40,555 Other debt securities 27,399 26,651 Total debt securities 275,886 273,644 Equity securities 25,308 25,421 Total Securities $301,194 $299,065 The amortized cost and fair value of securities held-to-maturity as of June 30, 1999 are summarized as follows: Amortized Fair (in thousands) Cost Value U.S. Treasury and government agencies $ 12,499 $ 10,998 States and political subdivisions 38,095 38,947 Mortgage-backed pass through certificates 17,594 17,527 Collateralized mortgage obligations 3,800 3,765 Total Securities $ 71,988 $ 71,237 7
Note 3 - Loans Major classifications of loans are summarized as follows: June 30 December 31 (in thousands) 1999 1998 Commercial, secured by real estate $ 372,038 $ 329,611 Commercial, other 296,549 279,406 Real Estate Construction 89,634 87,625 Real Estate Mortgage 388,986 399,035 Consumer 403,910 400,893 Equipment Lease Financing 7,337 5,816 $1,558,454 $1,502,386 Note 4 - Long-Term Debt Long-Term Debt consists of the following: June 30 December 31 (in thousands) 1999 1998 Trust Preferred Securities * $ 34,500 $ 34,500 Senior Notes 12,230 12,230 Revolving Bank Note 5,500 5,500 Other 1,494 1,593 $ 53,724 $ 53,823 Refer to the Corporation's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1998 for information concerning rates and assets securing long-term debt. * In April 1997, CTBI Preferred Capital Trust ("CTBI Trust"), a trust created under the laws of the State of Delaware, issued $34.5 million of 9.0% cumulative trust preferred securities ("Preferred Securities"). The Corporation owns all of the beneficial interests represented by common securities ("Common Securities") of CTBI Trust, which exists for the sole purpose of issuing the Preferred Securities and Common Securities and investing the proceeds thereof in an equivalent amount of 9.0% Subordinated Debentures which were issued by the Corporation. The Subordinated Debentures will mature on March 31, 2027, and are unsecured obligations of the Corporation. The Subordinated Debentures are irrevocably and unconditionally guaranteed by the Corporation and are subordinate and junior in right of payment to all senior debt and other subordinated debt. There are no payments due for this debt in the next five years. 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Community Trust Bancorp, Inc. (the "Company") is a multi-bank holding company headquartered in Pikeville, Kentucky. At June 30, 1999 the Company owned one commercial bank, one savings bank and one trust company. Through its affiliates, the Company has over sixty banking locations serving 85,000 households in Eastern and Central Kentucky and West Virginia. The Company had total assets of $2.18 billion and total shareholders' equity of $168 million as of June 30, 1999. The Company's common stock is listed on NASDAQ under the symbol CTBI. Market makers are Herzog, Heine, Geduld, Inc., New York, New York; J.J.B. Hilliard, W.L. Lyons, Inc., Louisville, Kentucky; Morgan, Keegan and Company, Inc., Memphis, Tennessee; Robinson Salomon Smith Barney, Atlanta, Georgia; J.C. Bradford & Co., Louisville, Kentucky; Keefe, Bruyette & Woods, Inc., New York, New York. Stock Dividend The Company's Board of Directors approved a 10% stock dividend in 1999. The stock dividend was paid on April 15, 1999 to shareholders of record on March 20, 1999, in addition to the regular quarterly cash dividends paid on (1) April 1, 1998 of 18 cents per share for shareholders of record on March 15, 1998, (2) July 1, 1998 of 18 cents per share for shareholders of record on June 15, 1998, (3) October 1, 1998 of 18 cents per share for shareholders of record on September 15, 1998, (4) January 1, 1999 of 19 cents per share for shareholders of record on December 15, 1998, (5) April 1, 1999 of 19 cents per share for shareholders of record on March 15, 1999 and (6) July 1, 1999 of 20 cents per share for shareholders of record on June 15, 1999. All per share data has been restated to reflect this stock dividend. Income Statement Review The Company's net income for the three months ended June 30, 1999 was $5.4 million or $0.49 per share as compared to $4.2 million or $0.38 per share for the three months ended June 30, 1998. Net income for the six months ended June 30, 1999 was $10.5 million or $0.95 per share as compared to $8.4 million or $0.76 per share for the six months ended June 30, 1999. The following table sets forth on an annualized basis the return on average assets and return on average shareholders' equity for the three and six month periods ending June 30, 1999 and 1998: Three months ended Six months ended June 30 June 30 1999 1998 1999 1998 Return on average shareholders' equity 12.96% 10.52% 12.66% 10.76% Return on average assets 0.99% 0.90% 0.97% 0.91% The Company's net income for the second quarter of 1999 increased $1,192 thousand or 28.1% as compared to the same period in 1998. Earnings per share increased $0.11 per share or 28.9% for the three months ended June 30, 1999, as compared to the second quarter of 1998. The increase in net income was the result of an increase in net interest income (11.7%) and a decrease in provision for loan losses (34.1%). A decrease in noninterest income (11.1%) and an increase in noninterest expense (9.4%) partially offset the factors contributing to the increase in net income. Provision for loan losses for the three months ended June 30, 1999 was $2.7 million, compared to $4.1 million for the same period in 1998. See "Provision For Loan Losses" below for an explanation of the decrease. 9
Net Interest Income Net interest income increased $2.2 million or 11.7% from $18.8 million for the second quarter of 1998 to $21.0 million for the second quarter of 1999. Interest income increased $2.1 million or 5.3% for the quarter ending June 30, 1999 as compared to the same period in 1998, while interest expense had a slight decrease of $143 thousand. The yield on interest earning assets decreased 65 basis points for the second quarter of 1999 as compared to the same period in 1998. The cost of interest bearing funds also decreased by 71 basis points for the second quarter of 1999 as compared to the same period in 1998. As a result, the net interest margin decreased from 4.43% for the second quarter of 1998 to 4.37% for the current quarter. The Company's loan portfolio, its highest yielding asset, continues to expand through new markets and internally generated growth. The Company's loan portfolio increased 5.4% from $1.48 billion for the second quarter of 1998 to $1.56 billion for the second quarter of 1999. 10
The following table summarizes the annualized net interest spread and net interest margin for the three and six months ended June 30, 1999 and 1998. Three Months EndedSix Months Ended June 30 June 30 1999 1998 1999 1998 Yield on interest earning assets 8.34% 8.99% 8.34% 9.03% Cost of interest bearing funds 4.52% 5.23% 4.58% 5.24% Net interest spread 3.82% 3.76% 3.76% 3.79% Net interest margin 4.37% 4.43% 4.32% 4.47% Provision for Loan Losses The analysis of the changes in the allowance for loan losses and selected ratios is set forth below. Six Months Ended June 30 (in thousands) 1999 1998 Allowance balance January 1 $26,089 $20,465 Allowance of acquired banks - 311 Additions to allowance charged against operations 4,705 6,558 Recoveries credited to allowance 3,102 2,136 Losses charged against allowance (8,409) (6,929) Allowance balance at June 30 $25,487 $22,541 Allowance for loan losses to period-end loans 1.64% 1.53% Average loans, net of unearned income $1,517,592 $1,443,777 Provision for loan losses to average loans, annualized 0.63% 0.92% Loan charge-offs, net of recoveries to average loans, annualized 0.71% 0.67% The Company decreased its provision for loan losses during the first six months of 1999. This is the result of the special charge taken in September 1998. In September 1998, CTBI took a special charge of $7.3 million to clean up problems in the Indirect Loan Portfolio. Six million ($6.0 million) of this charge was booked as additional Provision for Loan Losses. As a result, losses incurred in the Company's pre-1998 Indirect Lending Portfolio are charged against this provision. Net charge-offs represent the amount of loans charged off less amounts recovered on loans previously charged off. Net charge-offs as a percentage of average loans outstanding increased 4 basis points to 0.71% for the six months ended June 30, 1999 as compared to the same period in 1998. The Company's non-performing loans (90 days or more past due and non-accrual) were 1.37% and 1.26% of outstanding loans at December 31, 1998 and June 30, 1999, respectively. Any loans classified as loss, doubtful, substandard or special mention that are not included in non-performing loans do not (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources or (2) represent material credits about which management has knowledge of any information which would cause management to have serious doubts as to the ability of the borrowers to comply with the loan repayment terms. The Company does not believe there are currently any trends, events or uncertainties that are reasonably likely to have a material effect on the volume of its non- performing loans. 11
Noninterest Income The Company's noninterest income decreased 11.1% from $5.82 million for the three months ended June 30, 1998 to $5.17 million for the three months ended June 30, 1999. This decrease is largely contributed to a gain on the sale of fixed assets in the second quarter of 1998 of $1.3 million. A decrease of 42.3% in gains on the sale of loans is also a contributing factor. Service charges on deposit accounts increased 44.6% for the three months ended June 30, 1999 as compared to the same period in 1998. Noninterest Expense The Company's noninterest expense increased by 9.4% from $14.3 million for the three months ended June 30, 1998 to $15.7 million for the same period in 1999. All major categories of noninterest expense experienced increases for the quarter ended June 30, 1999 compared to the same quarter in 1998. This is primarily the result of the Company's 1998 acquisition of twelve additional branches (see discussion of acquisitions above). While the total noninterest expense increased, the noninterest expense expressed in terms of a percentage to average assets decreased from 0.76% for the three months ended June 30, 1998 to 0.71% for the same period in 1999. Cash Basis Income Three Months Ended June 30, 1999 Amortization Reported Core Deposit "Cash" Earnings Goodwill Intangible Earnings Income before income tax expense $ 7,823 $ 642 $ 145 $ 8,610 Income tax expense 2,391 205 51 2,647 Net income $ 5,432 $ 437 $ 94 $ 5,963 Basic earnings per common share $ 0.49 $ 0.04 $ 0.01 $ 0.54 Diluted earnings per common share $ 0.49 $ 0.04 $ 0.01 $ 0.54 Six Months Ended June 30, 1999 Amortization Reported Core Deposit "Cash" Earnings Goodwill Intangible Earnings Income before income tax expense $15,236 $ 1,284 $ 290 $16,810 Income tax expense 4,704 410 102 5,216 Net income $10,532 $ 874 $ 188 $11,594 Basic earnings per common share $ 0.95 $ 0.08 $ 0.02 $ 1.05 Diluted earnings per common share $ 0.95 $ 0.08 $ 0.02 $ 1.04 These calculations were specifically formulated by the Company and may not be comparable to similarly titled measures reported by other companies. Earnings per share calculations have been restated to reflect the 10% stock dividend payable April 15, 1999. Balance Sheet Review Total asset size was $2.25 billion at December 31, 1998 compared to $2.18 billion at June 30, 1999. During the last six months, loans increased 7.5% on an annualized basis from $1.50 billion to $1.56 12
billion. Federal funds sold decreased from $135.0 million at December 31, 1998 to $42.9 million at June 30, 1999. This decrease was driven by an increase in the loan portfolio and reductions in Federal Home Loan Bank advances of $32.7 million and total deposits of $42.4 million. The Company's largest liability, deposits, decreased from $1.92 billion as of December 31, 1998 to $1.88 billion as of June 30, 1999. Noninterest bearing deposits declined from $281.3 million at December 31, 1998 to $257.1 million at June 30, 1999. Interest bearing deposits decreased slightly from $1,639.8 million at December 31, 1998 to $1,621.7 million at June 30, 1999. The Company is using the liquidity from the branch acquisitions to pay down its advances from Federal Home Loan Bank as the opportunity arises. For the six months ended June 30, 1999, the Company reduced its Federal Home Loan Bank advances from $51.4 million to $18.7 million. Loans Loans increased from $1.50 billion as of December 31, 1998 to $1.56 billion as of June 30, 1999, primarily due to the growth of the Company's commercial loan portfolio. The category of commercial loans secured by real estate increased from $329.6 million as of December 31, 1998 to $372.0 million as of June 30, 1999 while other commercial loans increased from $279.4 million as of December 31, 1998 to $296.5 million as of June 30, 1999. Non-accrual and 90 days past due loans amounted to 1.37% of total loans outstanding as of December 31, 1998 and 1.26% of total loans outstanding as of June 30, 1999. Non-accrual loans as a percentage of total loans outstanding were 0.99% as of December 31, 1998 and at 1.02% at June 30, 1999. During the same period, loans 90 days or more past due decreased 14 basis points from 0.38% of total loans outstanding to 0.24%. The allowance for loan losses decreased from 1.74% of total loans outstanding as of December 31, 1998 to 1.64% as of June 30, 1999. This is consistent with our plan to absorb losses taken in our pre-1998 Indirect Lending Portfolio in the allowance after the special provision was made in September 1998. The allowance for loan losses as a percentage of non-accrual loans and loans past due 90 days or more was 126.9% at December 31, 1998 and 129.8% at June 30, 1999. The following table summarizes the Company's loans that are non- accrual or past due 90 days or more as of June 30, 1999 and December 31, 1998. As a % of Accruing loans As a % of Non-accrual loan balances past due 90 loan balances loans by category days or more by category (in thousands) June 30, 1999 Commercial loans, secured by real estate $ 7,247 1.62% $ 605 0.13% Commercial loans, other 3,550 1.17 1,033 0.34 Consumer loans secured by real estate 4,588 1.14 1,089 0.27 Consumer loans, other 562 0.14 969 0.24 Total $15,947 1.02% $ 3,696 0.24% December 31, 1998 Commercial loans, secured by real estate $ 5,294 1.61% $ 680 0.21% Commercial loans, other 4,458 1.56 708 0.25 Consumer loans, secured by real estate 4,771 0.98 2,077 0.43 Consumer loans, other 407 0.10 2,170 0.54 Total $14,930 0.99% $ 5,635 0.38% 13
Allowance for loan losses Management analyzes the adequacy of its allowance for loan losses on a quarterly basis. The loan portfolio of each market region is analyzed by each major loan category, with a review of the following areas: (i) specific allocations based upon a review of selected loans for loss potential; (ii) an allocation which estimates reserves based upon the remaining pool of loans in each category derived from historical net charge-off data, delinquency trends and other relevant factors and (iii) an unallocated portion of the allowance which provides for a margin of error in estimating the allocations described above and provides for risks inherent in the portfolio which may not be specifically addressed elsewhere. Off-balance sheet risk is addressed by including letters of credit in the Company's allowance adequacy analysis and through a monthly review of all letters of credit outstanding. The Company's loan review and problem loan analysis includes evaluation of deteriorating letters of credit. Volume and trends in delinquencies are monitored monthly by management, regional advisory boards and the boards of directors of the respective banks. Securities The Company uses its securities held-to-maturity for production of income and to manage cash flow needs through expected maturities. The Company uses its securities available-for-sale for income and balance sheet liquidity management. The book value of securities available-for-sale decreased from $301.1 million as of December 31, 1998 to $299.1 million as of June 30, 1999. Securities held-to- maturity declined from $83.4 million to $72.0 million during the same period. Total securities as a percentage of total assets were 17.1% as of December 31, 1998 and as of June 30, 1999. Disclosures Regarding Year 2000 Many companies have undertaken major projects to address "Year 2000" readiness, which relates to the recognition of dates beyond 1999. Many software programs and hardware systems are in a two digit format which will not properly process into the next century. Community Trust Bancorp, Inc. has already taken the steps to be "Year 2000 compliant". Community Trust Bancorp, Inc. realized the importance of Year 2000 readiness early and committed the people and resources to prepare its systems for January 1, 2000 and beyond. Achieving Year 2000 readiness is the company's top technology priority. Early on we formed both a Year 2000 Executive Steering Committee consisting of our top executives and top management, along with a Year 2000 Working Team made up of employees from each key business area. These company leaders have taken responsibility to identify and repair instances where dates may not process correctly within their area of operation and to test for interdependencies with clients, vendors and other corporate units. We have identified and contacted the bank's significant vendors to inquire about their own Year 2000 readiness plans, and are tracking and monitoring their progress. To ensure that all areas are covered, these efforts are coordinated and tracked centrally by the Year 2000 Working Team and reported to the Year 2000 Executive Steering Committee and the Board of Directors on a regular basis. Awareness - (Complete) - We defined the Year 2000 problem and allocated the appropriate resources necessary to perform our compliance work. We established both a Year 2000 Executive Steering Committee and a Year 2000 Working Team and developed an overall strategy for our Year 2000 efforts that encompasses in-house systems, service bureaus for systems that are outsourced, vendors, auditors, customers, and suppliers. Assessment Phase - (Complete) - We then assessed the size and complexity of the problem and the magnitude of the effort necessary to address our Year 2000 issues. This phase identified all hardware, software, networks, automated teller machines, and other processing platforms, along with customer and vendor interdependencies affected by the Year 2000 date change. We have completed an inventory of 14
systems in the bank, prioritized those that were identified, and made detailed plans to renovate and test modifications to make them Year 2000 ready. Our assessment went well beyond information systems and included environmental systems that are dependent on embedded microchips, such as security systems, elevators, and vaults. Renovation Phase - (Complete) - Strategies were developed for the code enhancements, hardware renovation or replacements, software upgrades and vendor certification, along with other associated changes. This work was prioritized based on the information gathered during our assessment phase. A millennium test site was developed to assure that testing of our hardware and software could occur outside of our working environment before being implemented on our production systems. Plans were made for on-going communications and monitoring of our key vendors, third-party service providers, and software providers throughout our Year 2000 project timeline. Validation Phase - (Complete) - Testing, while inherent in each phase, plays a key role in the success of our entire Year 2000 project. This phase includes testing of all incremental changes to hardware and software components, along with interfaces and connections with other systems. Also, validation from both internal and external users is required. During this phase, monitoring and communications with our service and software vendors will be maintained to assure these vendor efforts are tracked and their progress closely monitored. Our core third party data processor, one of the country's leading suppliers of financial institution data processing services, has already installed Year 2000 upgrades to their data processing systems. We have performed substantial off-site and on-site testing of this upgrade. Implementation Phase - (Complete) -Our data processing Systems will be certified as Year 2000 compliant. For any system failing certification, the business effect will be clearly assessed and the organization's Year 2000 contingency plans will be implemented. This phase will also ensure that any new systems or subsequent changes to verified systems are compliant with Year 2000 requirements. We have completed testing and determined that all of our major systems are Year 2000 ready. We have also verified that our systems will recognize that 2000 is a leap year, and continue to work closely with our client and vendor companies to verify that they also are prepared for the century date change. In addition, we have drafted our "Business Resumption Plan" which provides contingency plans for all identified Year 2000 issues. The costs associated with the Year 2000 project were $600,000 in 1998 and are estimated to be $886,000 in 1999. Because Community Trust Bancorp, Inc. is utilizing internal staff for the management and implementation of its Year 2000 Compliance program, it does not expect to incur any material costs with outside contractors. Subsequently, it does not anticipate a material increase in operating costs to be incurred. The cost of the Year 2000 project and the date by which the Company believes it will be Year 2000 compliant are based upon management's current best estimates, which were derived based upon numerous assumptions of future events, including availability of certain resources, third party modification plans and other factors. Actual results could vary from those anticipated. Liquidity and Capital Resources The Company's liquidity objectives are to ensure that funds are available for the affiliate banks to meet deposit withdrawals and credit demands without unduly penalizing profitability, and to ensure that funding is available for the Company to meet ongoing cash needs while maximizing profitability. The Company continues to identify ways to provide for liquidity on both a current and long-term basis. The subsidiary banks rely mainly on core deposits, certificates of $100,000 or more, repayment of principal and interest on loans and securities and federal funds sold and purchased to create long-term liquidity. The subsidiary banks also rely on the sale of securities under repurchase agreements, securities available-for-sale and Federal Home Loan Bank borrowings. Deposits decreased from $1.921 billion to $1.879 billion from December 31, 1998 to June 30, 1999. Noninterest bearing deposits decreased by $24.2 million while interest-bearing deposits decreased by $18.1 million. 15
Due to the nature of the markets served by the subsidiary banks, management believes that the majority of its certificates of deposits of $100,000 or more are no more volatile than its core deposits. During the periods of low interest rates, these deposit balances remained stable as a percentage of total deposits. In addition, arrangements have been made with correspondent banks for the purchase of federal funds on an unsecured basis, up to an aggregate of nearly $100 million, if necessary, to meet the Company's liquidity needs. The Company owns $299.1 million of securities valued at market price that are designated as available-for-sale and available to meet liquidity needs on a continuing basis. The Company also relies on Federal Home Loan Bank advances for both liquidity and management of its asset/liability position. These advances have sometimes been matched against pools of residential mortgage loans, which are not sold in the secondary market, some of which have original maturities of ten to fifteen years. Federal Home Loan Bank advances decreased from $51.4 million as of December 31, 1998 to $18.7 million as of June 30, 1999. The Company generally relies upon net inflows of cash from financing activities, supplemented by net inflows of cash from operating activities, to provide cash for its investing activities. As is typical of many financial institutions, significant financing activities include deposit gathering, use of short-term borrowing facilities such as federal funds purchased and securities sold under repurchase agreements, and issuance of long-term debt. The Company currently has a $17.5 million revolving line of credit, $12.0 million of which is currently available to meet any future cash needs. (See long-term debt footnote to the consolidated financial statements.) The Company's primary investing activities include purchases of securities and loan originations. In conjunction with maintaining a satisfactory level of liquidity, management monitors the degree of interest rate risk assumed on the balance sheet. The Company monitors its interest rate risk by use of the static and dynamic gap models at the one-year interval. The static gap model monitors the difference in interest rate sensitive assets and interest rate sensitive liabilities as a percentage of total assets that mature within the specified time frame. The dynamic gap model goes further in that it assumes that interest rate sensitive assets and liabilities will be reinvested. The Company uses the Sendero system to monitor its interest rate risk. The Company desires an interest sensitivity gap of not more than fifteen percent of total assets at the one-year interval. On a limited basis, the Company may use interest rate swaps and sales of options on securities as additional tools in managing interest rate risk. Interest rate swaps involve an exchange of cash flows based on the notional principal amount and agreed upon fixed and variable interest rates. In this transaction, the Company would typically agree to pay a floating interest rate based on London Inter- Bank Offering Rate (LIBOR) and receive a fixed interest rate in return. On options, the Company would typically sell the right to a third party to purchase securities the Company currently owns at a fixed price on a future date. The Company had no options outstanding at June 30, 1999. The Company's principal source of funds used to pay dividends to shareholders and service long-term debt is the dividends it receives from subsidiary banks. Various federal and state statutory provisions, in addition to regulatory policies and directives, limit the amount of dividends that subsidiary banks can pay without prior regulatory approval. These restrictions have had no major impact on the Company's dividend policy or its ability to service long-term debt, nor is it anticipated that they would have any major impact in the foreseeable future. In addition to the subsidiary banks' 1999 profits, approximately $14.5 million can be paid to the Company as dividends without prior regulatory approval. The primary source of capital for the Company is retained earnings. The Company paid cash dividends of $0.20 per share for the second quarter of 1999 and $0.18 per share for the second quarter of 1998. Earnings per share for the same periods were $0.49 and $0.38, respectively. The Company retained 59% of earnings for the second quarter of 1999. 16
Under guidelines issued by banking regulators, the Company and its subsidiary banks are required to maintain a minimum Tier 1 risk- based capital ratio of 4% and a minimum total risk-based ratio of 8%. Risk-based capital ratios weight the relative risk factors of all assets and consider the risk associated with off-balance sheet items. The Company must also maintain a minimum Tier 1 leverage ratio of 4% as of September 30, 1997. The Company's Tier 1 leverage, Tier 1 risk- based and total risk-based ratios were 6.68%, 8.64% and 9.89%, respectively as of June 30, 1999. As of June 30, 1999, management is not aware of any current recommendations by banking regulatory authorities which, if they were to be implemented, would have, or would be reasonably likely to have, a material adverse impact on the Company's liquidity, capital resources, or operations. Impact of Inflation and Changing Prices The majority of the Company's assets and liabilities are monetary in nature. Therefore, the Company differs greatly from most commercial and industrial companies that have significant investment in nonmonetary assets, such as fixed assets and inventories. However, inflation does have an important impact on the growth of assets in the banking industry and on the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation also affects other expenses, which tend to rise during periods of general inflation. Management believes the most significant impact on financial and operating results is the Company's ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest rate sensitive assets and liabilities in order to protect against the effects of wide interest rate fluctuations. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company currently does not engage in any derivative or hedging activity. Refer to the Company's 1998 10-K for analysis of the interest rate sensitivity. PART II - OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a vote of Security Holders The Company's Annual Meeting of Shareholders was held on April 27, 1999. The following items were approved: 1) Election of the following members to the Company's Board of Directors for the ensuing year. Nominee In Favor Withheld Charles J. Baird 7,589,048 136,218 Burlin Coleman 7,577,964 147,302 Nick A. Cooley 7,599,341 125,925 William A. Graham, Jr. 7,600,159 125,107 Jean R. Hale 7,589,111 136,155 M. Lynn Parrish 7,353,107 372,159 Ernest M. Rogers 7,594,878 130,388 Steven L. Lawson 7,599,036 126,230 2) Ratification of Ernst & Young, L.L.P. as the Company's independent certified public accountants for 1999. The votes of the shareholders on this item were as follows: In Favor Opposed Abstained 7,651,387 5,939 70,160 Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K a. Exhibits Exhibit 27. Financial Data Schedule b. Reports on Form 8-K None 18
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMUNITY TRUST BANCORP, INC. by Date: August 13, 1999 /s/ Jean R. Hale Jean R. Hale President and Principal Executive Officer /s/ Kevin Stumbo Kevin Stumbo Chief Accounting Officer